Buying stocks and shares can seem scary when you don't know what you're doing.
This guide explains what investing is, the risks involved, and how to build your first portfolio.
What is investing?
Investing is essentially buying something that you think you will be able to sell at a higher price later on.
Let’s clarify what investing isn’t: at one extreme, investing isn’t stashing your cash in a savings account nor is there one magic formula to investing.
While we all need cash in an instant-access account for emergencies, there’s no chance of you growing your money beyond the small amount your bank will pay in interest rates.
At the other end of the scale, investing isn’t gambling. If you make a wrong bet at your local bookies, you will lose all of your money.
In contrast, while you’re likely to experience losses when investing, you’re less likely to lose the lot and there is a chance you make up those losses over time.
Why invest? Here are three reasons:
Building up cash isn’t enough
Are you often shocked at the bill when you fill up with petrol or do your weekly shop? Yes, the cost of living is rising.
Buying the same amount of stuff is becoming more expensive over the long term. The low interest rates offered by banks and building societies are not enough to beat inflation which at the moment is 5.4%.
The average rate across all banks on easy-access accounts is currently 0.22%, compared to 0.56 per cent in February 2020, according to Moneyfacts.
Your money can really multiply in the long run
Let’s assume you invested £10,000 over five years (assuming 5% growth), and put the same amount in a savings account paying you an interest rate of 1%. After five years:
Savings pot = £10,510.
Investments = £12,763
And actually due to the impact of inflation eroding the spending power of the cash in your savings account, in real terms it would be worth even less. After 5 years, at the current rate of CPI at 5.5%, your savings pot would in fact be worth £8,087.
The power of compound interest
This is what Einstein called the “eighth wonder of the world”.
Imagine a snowball, rolling down a snowy hill. The longer it rolls down the hill, the more snow it captures, and the bigger it gets. And the bigger it gets, the larger a surface area it has to capture even more snow.
Now replace the snow with money. The longer you give an investment to grow, the better. You have your original investment, plus the return you make each year, and that in turn will earn interest.
Effectively the interest earns interest and so your money grows at a faster rate. The “snowball” effect.
How to start investing
What should I do before I get started?
- Pay down any expensive debt with high interest rates such as a credit card or overdraft. Otherwise the interest payments would offset any investment gains. Read more about whether to pay down debt or save here.
- Make sure you have a “rainy day fund” of between three and six months’ earnings. This is money for emergencies like your boiler breaking.
If you are still worried about investing, it is important to bear in mind that nothing is risk free when it comes to your money.
Investing: markets can go up and down
Saving: inflation can eat into your pot
Keeping your money in cash may feel the safest option but you’ll be losing money in real terms. The rising cost of living means your money won’t go as far in the future.
Questions to ask yourself
Make sure you understand what is motivating you to invest. Ask yourself:
- What are my investment goals?
- How long am I happy to leave my money tied up for?
- Am I comfortable tying my money up in investments for at least five years? (if not, it might not be a good idea to invest)
- How much can I afford to invest?
- How much could I stomach seeing my fall in value along the way?
- Can I hold my nerve and avoid selling if my investments drop? (you should wait for markets to rise again to avoid crystallising losses)
Steps to get started
Now you are ready to start investing. Here are some steps, which we go into in more detail in this article:
- Choose an investment platform
- Through the platform you can open a tax-free wrapper like an ISA or a pension
- Decide on an investment strategy: DIY or ready-made?
- Set a budget (start with a small amount of money)
Choosing a platform
The easiest an cheapest way to invest is through an investment platform.
Just like when you purchase sports clothes or jewellery, there are “shops” for buying and selling shares and funds.
They are often called “fund supermarkets” which is just another name for an investment platform. Most will have useful websites and apps to help guide you through the investment process.
You will be charged three types of fee:
- One for using the platform
- Another when you buy or sell your investment
- If you buy a fund, you will also have to pay a management fee (this fee is separate to the platform)
A warning to beginner investors: Always. Watch. Fees.
The fees charged by the investment companies will erode the money you make, which we explain here. So, make sure you are getting good value for money.
What can I invest in?
We have outlined some of the most common types of investments below.
Many sure you only invest in something you understand. So if you decide to buy shares in a company, make sure it’s a company that you know about or even use yourself.
The same can be said for financial products. If an investment product seems complicated and you’re struggling to wrap your head around it, don’t touch it with a barge pole.
A share is a little piece of a company. When you buy a share you own a slice of that firm, so when it does well, you do too.
You earn money when:
- The value of your shares go up if the company does well (which is your investment return)
- Or by receiving a portion of the profits that these companies make, known as dividends
Here are the pros and cons of buying stocks yourself:
You can pick the exact company you want to buy stocks for, from Rolls-Royce to Hotel Chocolat
If the company is successful the rewards can be substantial in share price increases and dividend payments
You are picking the shares so you have to make a call on the future growth of companies
If you buy stocks with a firm that performs badly, you could lose your money
You lend money to a company or country. You will be paid a set amount at the end of the period when the bond “matures”, as well as regular interest payments known as coupons.
- Generally speaking, bonds are considered lower-risk than shares.
- Generally speaking, bonds are considered lower-risk than shares.
Instead of choosing your own individual shares, you can put your money into a mutual fund. This is effectively a group of shares, though managers can invest in other types of asset like bonds.
If buying a share is like backing the star player of a football team, a fund is equivalent to picking the entire squad. So if one player doesn’t do well, there are others who can pick up the slack.
You have a choice between:
- Passive funds that track a stock market
- Active funds where a professional investor picks stocks on your behalf
Here are the pros and cons of funds:
- A manager uses their expertise to decide which shares and range of assets to buy and sell
- Funds include many types of investment so are often less risky than individual shares
- Fund managers charge a fee
- The overall value can still fall despite having a range of assets to balance risk
We have all seen how house prices have increased so it’s little wonder that people invest in property.
While most people think of residential property investment, you can also invest in commercial property like warehouses and shopping centres.
A good way to invest in commercial property is buying an investment trust where a manager selects a number of properties to invest in.
You could also invest smaller amounts in other asset types, such as precious metals like gold and silver.
Precious metal investments can help diversify your portfolio and tend to be uncorrelated to the stock market. In other words, if stock markets fall, you may find that the price of gold rises as people flock to this “safe haven” asset to house their cash.
You can invest in precious metals by buying an investment fund that specialises in this sector.
DIY or ready-made?
Be honest: how much time and brain space are you prepared to dedicate to your investments?
If you are keen to go down the DIY route, picking your own shares is like tending to an allotment: it’s not a short term solution and it will require careful monitoring.
After the initial excitement of picking your own stocks, you may realise that you don’t have the time or expertise to go it alone.
Luckily, there are solutions to this:
- You can buy a few actively managed funds where a professional stock picker will select investments on your behalf.
- Invest in a tracker or exchange traded fund (ETF) which mimic the ups and downs in the stock market.
- Another option is to buy a ready-made portfolio through a robo-adviser.
What is an actively managed fund?
This is where managers buy and sell a pool of investments on your behalf to try to outperform a particular market.
For this, you will have to spend time finding a fund manager with a good track record whose investment technique you believe in.
The fees are higher than for tracker funds, but they have the potential to outperform the market.
What is an ETF in investing?
ETF stands for exchange traded fund. An ETF will invest in a pool of companies that are part of an index such as the FTSE 100 or S&P 500.
An index like the S&P 500 measures the share price performance of the 500 largest listed firms in the US. So if you bought an ETF that tracks the S&P 500, you would be investing in the 500 largest companies in the US.
Unlike a mutual fund, ETFs are traded on a stock exchange in a similar way to buying a direct share in a company.
With ETFs, no one selects stocks on your behalf, so they tend to be low cost compared to actively managed funds. This has made them very popular.
What is a robo-adviser?
For an extra helping hand, you could look for a ready-made investment portfolio, where you don’t even need to pick the shares or funds.
As the name suggests, the portfolio is created and managed for you. You usually select the level of risk you want to take, such as cautious, balanced or adventurous.
Diversify your portfolio
Diversification means having a wide range of assets that perform differently in certain conditions.
Or as the old expression goes: don’t put all your eggs in one basket.
It means that no matter how the economy is doing, some types of investments will thrive.
You only really need to worry about this if you are picking your own shares and funds. This is because if you have opted for a ready-made portfolio, the investment should diversify your investments on your behalf.
You can diversify by:
Asset class, such as buying shares and bonds along with a fund that tracks the price of gold
Sector, such as making sure you have a mix of financial and industrial companies
Geography, such as taking advantage of a booming American or Indian economy while European companies stagnate.
But don’t go overboard…
Do not confuse diversification with owning dozens of investments. A portfolio with too many holdings will require more monitoring and often lacks focus.
If you buy too many funds, you might end up with some overlap if the fund managers own the same companies.
How much money should a beginner invest?
It all depends on your financial goals and personal situation.
Remember that it’s always a good idea to have an emergency fund of at least three months’ earnings in a savings account before you invest.
You should be prepared to leave your money tied up into your investment for at least five years to give it enough time to grow.
Some investment platforms now let you invest with just a few pounds. So you might want to start with small amounts first to try out the features before trickling in more of your savings as time goes on.
You don’t have to be super wealthy to invest
Lump sum or regular savings?
Investing a lump sum will get your money working for you immediately and compound any returns from the start.
However, if the market dips, the whole sum will be exposed to the fall.
If you drip-feed a fixed amount over time, it can smooth out the highs and lows of the market. In other words, it will buy fewer shares when prices are high and more when they are low.
This is known as pound-cost averaging.
The drawback is that you can miss out on the full benefit of rises in the markets in the early years as you will have a much smaller sum of money invested to begin with.Read More